Memo No. Issue Summary No. 1 * Issue Date September 12, Meeting Date(s) EITF September 22, 2016

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1 Memo No. Issue Summary No. 1 * Memo Issue Date September 12, 2016 Meeting Date(s) EITF September 22, 2016 Contact(s) Thomas Faineteau Project Lead / Author (203) Rob Moynihan EITF Coordinator (203) Caro Baumann John Althoff Co-Author/Postgraduate Technical Assistant EITF Liaison (203) Project Project Stage Issue(s) Issue 16-C: Accounting for Service Concession Arrangements Initial Deliberations Issue 1 Determining the Customer of the Operation Services in a Service Concession Arrangement Subissue 1A Recording Revenue for Construction Services When All the Consideration is Tied to the Operation Services Issue 2 Whether Major Maintenance is a Separate Deliverable Subissue 2A If Major Maintenance is Not a Separate Deliverable, Whether the Operating Entity Can Capitalize Major Maintenance Costs Objective of This Memo 1. The purpose of this memo is to assist the Task Force in addressing various accounting issues for transactions within the scope of Topic 853, Service Concession Arrangements. Background Information 2. A service concession arrangement (SCA) is an arrangement between a grantor (a government or public sector entity) and an operating entity whereby the operating entity will operate the grantor s infrastructure (for example, airports, roads, bridges, tunnels, prisons, and hospitals) for a specified period of time. The operating entity may also * The alternative views presented in this Issue Summary are for purposes of discussion by the EITF. No individual views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting Principles until the Task Force makes such a determination, exposes it for public comment, and it is ratified by the Board. Page 1 of 35

2 maintain the infrastructure, and may also be required to provide periodic capital-intensive maintenance (major maintenance) to enhance or extend the life of the infrastructure. The infrastructure may already exist or may be constructed by the operating entity during the period of the SCA. 3. In exchange for providing its services, the operating entity may receive payments from the grantor, may be given the right to charge the public (third-party users) to use the infrastructure, and/or may receive an unconditional guarantee from the grantor (that is, a minimum guaranteed amount to be received by the operating entity). In some cases, the operating entity may be required to make payments to the grantor. For example, it may be required to pay the grantor a specified percentage of the consideration received from third-party users when that consideration exceeds a specified amount, or it may be required to make an upfront cash payment to the grantor in exchange for the right to operate the grantor's infrastructure and charge users of the infrastructure. 4. When third-party users pay for the use of a service (for example, drivers who use a toll road), to some extent the operating entity, the grantor, or both, bear the risk that the public has the willingness to use the service for a fee. The uncertainty connected with the generation of cash inflows and whether those inflows will cover operating costs is referred to as demand risk in International Financial Reporting Interpretations Committee (IFRIC) Interpretation 12, Service Concession Arrangements (IFRIC 12). Page 2 of 35

3 5. Accounting Standards Update No , Service Concession Arrangements (Topic 853), was issued in January Update states that SCAs are within the scope of Topic 853 when both of the following conditions are met: (a) (b) The grantor controls or has the ability to modify or approve the services the operating entity must provide with the infrastructure, to whom it must provide them, and at what price The grantor controls, through ownership, beneficial entitlement, or otherwise, any residual interest in the infrastructure at the end of the term of the arrangement. For SCAs within the scope of Topic 853, the operating entity should not account for the infrastructure as a lease (because the operating entity does not have the right to control the use of the grantor's infrastructure) or as property, plant, and equipment (PP&E) (because the operating entity does not control the infrastructure under the terms of the arrangement). 6. Topic 853 does not provide further guidance on the accounting for SCAs. Instead, an operating entity should look to other Topics, as applicable, to account for the various aspects of an SCA. However, the application of other Topics to the unique nature of SCAs has recently led to a number of accounting questions, including questions related to the application of Topic 605, Revenue Recognition, when accounting for construction and operation services, and major maintenance. 7. In addressing those questions, some have looked to the guidance in IFRIC 12, which has a similar scope to the scope of Topic 853 and similarly concludes that the infrastructure is not a lease or PP&E of the operating entity. However, IFRIC 12 provides additional recognition, measurement, and presentation guidance; for example, a distinction is made between two accounting models (both of which may exist within a single contract) based on the nature of the consideration received by an operating entity in exchange for construction or upgrade services: (a) Financial asset model The operating entity recognizes a financial asset for its unconditional contractual right to receive a specified or determinable amount of Page 3 of 35

4 cash (or another financial asset) from the grantor in return for constructing or upgrading the infrastructure, and then operating and maintaining the infrastructure for a period of time. (b) Intangible asset model The operating entity recognizes an intangible asset for its right to charge for use of the infrastructure that it constructs or upgrades, and then operates and maintains for a period of time. The amounts are contingent on the extent of public use of the infrastructure. 8. The FASB received an agenda request describing various accounting issues related to the accounting for SCAs for which diversity in practice has been observed under GAAP. At the agenda prioritization meeting held on August 31, 2016, the Board decided to add a project to the EITF agenda on the accounting for service concession arrangements (Issue 16-C). The scope of this project relates solely to transactions that meet the specific scoping criteria included in Topic While the agenda request specifically relates to the accounting guidance under Topic 605, the staff believes that similar issues generally exist under Topic 606, Revenue from Contracts with Customers. For example, (a) determining who the customer is, (b) whether major maintenance is a separate performance obligation, and (c) whether major maintenance may be capitalized under the guidance in Subtopic , Other Assets and Deferred Costs Contracts with Customers. Staff Outreach 10. The staff performed outreach with four large accounting firms to discuss the issues raised in this agenda request. The staff also discussed SCAs with a member of the IASB staff and with two members of the Private Company Council to further the staff s understanding of the arrangements and issues raised in the agenda request. The staff spoke to a regulator who noted that they do not typically receive questions on SCAs in a GAAP context. Based on searches of SEC filings and outreach performed, the staff s understanding of SCAs in the U.S. is that most operating entities are private companies or subsidiaries of larger international companies. Page 4 of 35

5 11. The staff also considered the user perspective on this topic and discussed it with a senior investor liaison at the FASB. While some operating entities may be public entities, most are private entities and, therefore, the users of operating entity financial statements would presumably have a relatively higher level of access to management. The staff thinks that comparability of information would be important to financial statement users that are comparing financial statements across different entities, and a goal of this Issue is to reduce the diversity in practice on the accounting for SCAs. Commonly, users of operating entity financial statements in an SCA scenario are institutions that provide lending to the operating entity. Illustration 12. To put the issues to be addressed by the Task Force into context, consider the following example of an arrangement between a grantor and an operating entity that is within the scope of Topic 853. Base assumptions Infrastructure Duration of the arrangement Operating entity s obligations under the SCA to the grantor Operating entity s rights under the SCA Toll road 20 years Operate and maintain the toll road ( operation services ) Resurface the toll road every 6 years Right to charge, collect, and retain toll fees from drivers who use the toll road (estimated at $1.5 billion over the 20-year period) Page 5 of 35

6 Infrastructure already exists. Additional assumptions Scenario 1 Scenario 2 Operating entity makes an upfront, onetime payment of $500 million to the grantor for the right to operate the toll road and charge drivers using the toll road. Infrastructure to be constructed by the operating entity. Construction services (estimated to cost $475 million) give the operating entity a right to charge drivers who use the toll road. Fair value of the construction services is estimated at $500 million. Issue 1: Determining the Customer of the Operation Services in an SCA 13. Some stakeholders assert that it is not clear who the customer of the operation services is (that is, the grantor or the third-party users), which therefore results in diversity in practice. In contrast, it is generally accepted that the grantor is the customer of any construction services provided by the operating entity. This is because the construction services create or enhance an asset the grantor controls. 14. The identification of the customer of the operation services is important in the application of GAAP revenue recognition guidance, because it affects the operating entity s analysis regarding the presentation of payments made by the operating entity to the grantor, if any (for example, the $500 million upfront payment in Scenario 1). Such payments could be treated as either a reduction of revenue (if the grantor is the customer) or an operating expense (if the third-party users are the customer) over the course of the arrangement. This question is also important for certain SCAs in which the operating entity provides construction services (see Subissue 1A). 15. Although the question raised in the agenda request for this issue is about who is the customer of the operation services, the staff thinks it is helpful to consider the overall nature of the arrangement. To assess the overall nature of the arrangement, one would consider, for example: What are the enforceable rights and obligations in the contract? What are the specified goods or services (or deliverables) and to whom are those specified Page 6 of 35

7 goods and services being provided? Is the nature of the entity s promise to arrange for the provision of those specified goods or services by another party? Industry Practice and Outreach 16. For Issue 1, some stakeholders assert that the grantor is always the customer irrespective of the type of arrangement (construction and operation services; or operation services only) based on the scope and decisions made in Topic 853. Other outreach participants generally support the view that the grantor is the customer, particularly for SCAs involving both construction and operation services. They believe that more judgment is involved particularly when the arrangement is for operation services only and the operating entity makes an upfront payment to the grantor for the right to charge the users (as illustrated in Scenario 1). Finally, another stakeholder observed that the customer should be determined based on the facts and circumstances of the arrangement, including consideration of demand risk (that is, an evaluation that is similar to IFRIC 12). Accounting Guidance under IFRIC At its January 2016 and July 2016 meetings, the IFRS Interpretations Committee (the Interpretations Committee) held discussions on a similar agenda request it received. 1 The Interpretations Committee concluded that the requirements in existing IFRS standards are sufficient to address how an operating entity accounts for payments that it makes to a grantor. Such accounting depends on the nature of the payments made by the operating entity and, if applicable, which IFRIC 12 model applies. Consequently, the Interpretations Committee decided not to add this issue to its agenda. The FASB staff prepared the following flowchart to summarize the Interpretations Committee s observations. 1 Agenda request IFRIC 12 Service Concession Arrangements Payments by an operator to a grantor in a service concession arrangement in the scope of IFRIC 12, available at Projects/IFRIC-12-Payments-by-an-operator-to-a-grantor-in-sca/Pages/default.aspx Page 7 of 35

8 Is payment for a right to a good or service that is separate from the service concession arrangement? Yes Operator accounts for payments applying applicable IFRS Standard(s). No Is payment for the right to use an asset that is separate from the infrastructure within the scope of IFRIC 12? No Does the operator only have a contractual right to receive cash from the grantor (i.e., the financial asset model in IFRIC 12)? No Does the operator only have a right to charge users of the public service (i.e., the intangible asset model in IFRIC 12)? No Does the operator have both a contractual right to receive cash from the grantor and a right to charge users of the public service (i.e., both the financial asset model and intangible asset model in IFRIC 12)? Yes Yes Yes Yes Operator assesses whether the arrangement contains a lease. If so, account for payments applying the Leases Standard. Operator accounts for payments in accordance with IFRS 15, Revenue from Contracts with Customers Consideration payable to a customer (i.e., reduction of transaction price). Operator has received an intangible asset in exchange for construction / upgrade services and the payments to grantor => Account for payments applying IAS 38, Intangible Assets. Operator considers whether payments represent payments made for the intangible asset, or consideration payable to a customer, or both. Staff Analysis and Alternatives 18. Stakeholders have identified two alternatives that may be considered for resolution of Issue 1. Alternative A: The grantor is the customer in all cases. Alternative B: The customer should be determined based on the facts and circumstances of the transaction, including consideration of demand risk. Alternative A: The grantor is the customer in all cases. 19. Proponents of Alternative A assert that the operating entity s customer can only be the grantor based on the scope of Topic 853 and the grantor s role within the arrangement. Page 8 of 35

9 Topic 853 applies to an operating entity when the SCA meets both of the following conditions (paragraph ): (a) (b) The grantor controls or has the ability to modify or approve the services the operating entity must provide with the infrastructure, to whom it must provide the services, and at what price. The grantor controls, through ownership, beneficial entitlement or otherwise, any residual interest in the infrastructure at the end of the arrangement. These proponents observe that having two customers (the grantor for the construction services and the third-party users for the operation services) is inconsistent with the two conditions noted above that define the scope of Topic 853. Proponents note the operating entity is acting as the grantor s service provider (or outsourcer) to operate and maintain the grantor s infrastructure, and the only parties to the executed service arrangement are the grantor and the operating entity. In the proponents view, the fact that the operating entity may be collecting consideration directly from a third-party is irrelevant, because the grantor can dictate, or has the ability to modify or approve, the services the operating entity provides and the fees the operating entity collects (and what portion of those fees the operating entity can retain). 20. Proponents of Alternative A also refer to the decisions made in Topic 853 that the infrastructure is not property, plant, and equipment of the operating entity because the operating entity does not control the infrastructure, and should not be accounted for as a lease because the operating entity does not have control over the use of the infrastructure. Accordingly, they assert that the customer of the operating entity can only be the grantor, rather than the users of the infrastructure; the operating entity cannot deliver a service to the users, such as delivering the use of a toll road to drivers, because the operating entity does not control the use of the infrastructure itself in order to provide that service. 21. One proponent of Alternative A notes that the grantor is the customer of the operating entity because, from a legal standpoint, the rights a user receives by using the infrastructure are different from those it typically receives when purchasing a product or a service (for example, from a store). In an SCA, the grantor has the ability to bring legal action against the operating entity (for example, for not performing as required under the Page 9 of 35

10 arrangement). This proponent observes that it would be more difficult for a driver who uses a toll road to bring action against the operating entity. 22. Opponents of Alternative A observe that this alternative does not take into consideration the fact that there are SCAs in which the operating entity primarily bears demand risk. They believe that in situations in which the consideration to be received is a direct function of third-party usage, this is an indication that the third-party users are the customers. They also note that the application of IFRIC 12, which is similar in scope to Topic 853 and similarly concludes that the infrastructure is not PP&E or a lease of the operating entity, can result in either the grantor or the third-party users being the customer. Alternative B: The customer should be determined based on the facts and circumstances of the transaction, including consideration of demand risk. 23. Proponents of Alternative B believe that it is important to evaluate the terms of the SCA including considering demand risk. If the grantor primarily bears demand risk (for example, the grantor pays the operating entity for the operation services performed), the operating entity s customer is the grantor. These proponents assert that if the operating entity primarily bears demand risk (for example, the operating entity only receives the right to charge users), the operating entity s customers for the operation services are the third-party users, and the operating entity has a need and motivation to provide high quality services to attract sufficient third-party users to cover costs and generate a profit. They note that this alternative is more closely aligned with IFRIC Some proponents of Alternative B also point to the current definitions in the Master Glossary of the Codification, which note that a customer is a user or a consumer that purchases a vendor s products or services for end use. They observe that based on the facts and circumstances of the transaction (for example, when the grantor is not guaranteeing a return to the operating entity), the public may be considered the end user and therefore the customer. 25. Opponents assert that if Alternative B is selected to resolve Issue 1, the EITF would need to consider reversing the prior decisions made in Topic 853 that the infrastructure is not a lease. These opponents note that to be able to identify the third-party users as the Page 10 of 35

11 customer of the operating entity, the operating entity would need to have the right to use the infrastructure (that is, there is a lease) in the first place if the operating entity is deemed to be providing the use of that toll road to the third party. 26. Some opponents of Alternative B, while understanding the economic standpoint of such alternative, observe that demand risk is not defined in GAAP and, therefore, should not be a factor in determining who the customer is. Furthermore, exposure to demand risk does not outweigh the fact that the grantor controls the services to be provided and the price charged for those services. Opponents also note that under Topic 606, demand risk is not a factor in determining the nature of the entity s promise or identifying the entity s customer. For example, consider an arrangement in which Entity 1 provides Entity 2 with a license to use a drug compound in Japan. Entity 2 plans to use the license to manufacture and sell a drug in Japan. The consideration in this arrangement is the 20 percent of the net sales of the drug in Japan that Entity 2 gives to Entity 1. This arrangement typically would be accounted for under Topic 606. The staff thinks the accounting conclusions under Topic 606 typically would be that Entity 1 s customer is Entity 2 and the consideration (transaction price) is a sales-based royalty for a license of intellectual property. A party that purchases the drug from Entity 2 in Japan is not a party to the arrangement between Entity 1 and Entity 2. The fact that Entity 1 s consideration is based on purchases by third parties in Japan does not make those third parties in Japan a party to the contract between Entity 1 and 2. Other examples of similar arrangements include hotel management services, transaction processing, licenses for media content, and licenses for symbolic intellectual property (for example, the logo of a sport s team), among others. Staff Recommendation 27. Considering the role of the operating entity in an SCA and the decisions reflected in Topic 853 that the operating entity does not own or lease the infrastructure and does not control the services to be provided, the staff recommends Alternative A. The staff also observes that potentially having two customers in a single arrangement when construction services and operation services are involved appears counter-intuitive at first, and creates accounting complexities as described in Subissue 1A and Issue 2. Alternative A would Page 11 of 35

12 simplify the process of determining who the customer is (since it would be the grantor in all cases), would increase comparability, and would reduce diversity in practice. In addition, in the staff s view, Alternative A is the appropriate application of Topic 606, as further described below. 28. The staff performed additional research to determine whether Alternative A would be inconsistent under Topic 606. The staff notes that paragraph states: An entity shall apply the guidance in this Topic to a contract (other than a contract listed in paragraph ) only if the counterparty to the contract is a customer. A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity s ordinary activities in exchange for consideration. The staff considered the following: (a) (b) (c) (d) The nature of the promise in an SCA is for the operating entity to operate and maintain (and potentially construct) the infrastructure that will be used to provide a public service; Third-party users typically do not have direct participation in the negotiation (and typically do not have direct influence) of the services to be provided by the operating entity or the price of those services; Third-party users typically do not have the direct ability to terminate or modify the contract between the grantor and the operating entity; Determining who the customer is generally should not be determined solely on the basis of whether payment is received from the grantor or the third-party users. The definition of a customer under Topic 606, the factors outlined above, the role of the operating entity in an SCA, and the decisions reflected in Topic 853 that the operating entity does not own or lease the infrastructure and does not control the services to be provided, would suggest that the customer is the grantor in all cases under Topic 606 for SCAs in the scope of Topic 853. Page 12 of 35

13 Principal versus agent guidance considerations 29. In evaluating Issue 1, the staff also considered the potential interaction between determining who the customer of the operation services is and the application of the principal versus agent guidance in Topic 605 (or Topic 606). In other words, assessing whether an entity is a principal or an agent in a transaction may inform the entity as to which party is its customer with respect to the promise in the contract (the operation services). 30. In the staff s view, the overall nature of the promise in an SCA is for the operating entity to operate and maintain (and potentially construct) the infrastructure that will be used to provide a public service. Using a toll road infrastructure as an example, operation of the road could entail activities such as having personnel to collect tolls from drivers, and to monitor and coordinate general roadworks to ensure public safety (such as supervising, patrolling and managing incidents). Maintenance of the road could entail activities to ensure the road is in good working condition, such as performing winter maintenance and roadside maintenance. 31. In the staff s view, the operating entity does not provide drivers with access to the road. This is because the operating entity does not control the road (either through ownership or a lease). In some contracts, the operating entity collects a fee and opens a gate so a driver can enter the road; however, this is not the notion of access to which the staff is referring. The activities of collecting a fee and opening a gate are part of the overall promise (deliverable) of operating and maintaining the road. Likewise, the activities of plowing and paving are part of the overall promise (deliverable) of operating and maintaining the road. Despite all of the different activities that the operating entity is obligated to perform, the operating entity cannot, for example, decide to close the road at its sole discretion or decide that drivers must become members of a club in order to enter the road. The operating entity does not have control over those decisions; those decisions are controlled by the party that owns the road (those factors are among the reasons under GAAP that the arrangement does not contain a lease). 32. Because the staff views the nature of the overall promise (deliverable) as one in which the operating entity is servicing an asset that it does not control (for example, the road), the Page 13 of 35

14 staff thinks that the contract involves two parties: the grantor and the operating entity. Accordingly, the staff believes that the principal versus agent guidance is not relevant for Issue 1. Stakeholders with whom the staff spoke also do not apply the principal versus agent guidance to determine the customer of the operation services in an SCA. Those stakeholders also observed that applying the principal versus agent guidance to SCAs would add complexity to the evaluation. The operating entity does not control an asset nor does it have the right to use an asset (a lease) to fulfil its promise, and therefore it would be challenging to determine what service the operating entity is providing to the thirdparty users. Question 1 for the Task Force 1. Does the Task Force agree with the staff s recommendation that the customer of the operation services is the grantor in all cases? Disclosures 33. Considering there are no disclosure requirements in Topic 853, the staff evaluated whether additional disclosures would be required following the resolution of Issue 1. In doing so, the staff considered the existing disclosure requirements in Topic 605 and Topic 606; noting that neither Topic explicitly requires the disclosure of how the customer is determined. The staff also notes that Topic 606 includes extensive disclosure requirements and a disclosure objective so that entities can understand the purpose of the disclosure requirements (which is to enable users to understand the nature, timing and uncertainty of revenue and cash flows arising from contracts with customers) and determine the amount of information to disclose about contracts with customers. Staff Recommendation 34. Considering the above, the staff does not recommend adding disclosure requirements with regards to Issue 1, regardless of who the customer in the transaction is. That is, an entity should use judgment and consider the disclosure objective in Topic 606 in determining how much to disclose about its revenue transactions with customers. However, the staff Page 14 of 35

15 observes that an entity is required to disclose certain information as a result of adopting a change in accounting principle in accordance with Section , which may include disclosing, in the year of adoption, the reasons for, and impact of, the change in accounting if an entity was following an approach that differed from any guidance finalized by the Task Force and Board on this Issue. Refer to the Transition Disclosures section for further information on the required disclosures in Section Question 2 for the Task Force 2. Does the Task Force agree with the staff s recommendation that no additional disclosures are required following the resolution of Issue 1? Subissue 1A: Recording Revenue for Construction Services When All the Consideration Is Tied to the Operation Services Depending on the resolution of Issue 1, there could be situations in which the operating entity has two customers within a single arrangement, as illustrated below. This raises questions in the application of GAAP revenue recognition guidance when all the consideration in the arrangement is tied to the operation services (as illustrated in base example Scenario 2 above). The staff notes that this is not an issue when the grantor is the customer of the construction and operation services because the operating entity applies Subtopic , Revenue Recognition Multiple Element Arrangements, in which it (a) identifies the separate deliverables in the SCA, (b) allocates the consideration among the separate deliverables identified, and (c) applies the revenue recognition criteria separately to each deliverable. 2 Subissue 1A is not applicable if the Task Force tentatively concludes for Issue 1 that the grantor is the customer in all cases (Alternative A of Issue 1) Page 15 of 35

16 36. To illustrate the accounting implications of Subissue 1A, consider the following two accounting approaches that an operating entity may apply when it has two customers: (a) (b) The operating entity recognizes revenue for the construction services provided to the grantor in exchange for a right to collect tolls from the drivers (that is, an intangible asset), which is measured at fair value. Under Scenario 2, the operating entity recognizes $500 million of revenue during the construction phase (that is, the fair value of the construction services provided). It then recognizes $1.5 billion of revenue during the operations phase for the tolls collected from drivers (and it also amortizes the intangible asset recognized during the construction phase over the period of the operation services). Therefore, revenue recognized would be in excess of the cash consideration received during the SCA. This approach is consistent with Example 2 in IFRIC 12. The operating entity allocates the consideration in the SCA between the construction services and the operation services. Using Scenario 2, the operating entity allocates the consideration of $1.5 billion between the construction and operation services, and applies the revenue recognition criteria to each deliverable. 3 Industry Practice and Outreach 37. For some stakeholders, this question is not relevant since they believe that the grantor is always the customer. For the other stakeholders who believe that third-party users may be considered the customer, some prefer recognizing an intangible asset and some do not have a preference and could make arguments for both views considering there is no existing GAAP guidance for answering that question (however, they also believe that, 3 Because the consideration is contingent on the use of the toll road by drivers, there are limitations on the revenue that can be allocated to the delivered item (construction phase) as described in paragraph However, by the end of the term of the arrangement, the operating entity will have recognized $1.5 billion in revenue. Page 16 of 35

17 generally, the grantor is the customer of all services in SCAs that involve construction and operation services). Accounting Guidance under IFRIC When the consideration in an SCA is tied to the operation services (for example, when it is based on use of a toll road by drivers), the operating entity recognizes revenue during the construction services (and an intangible asset) based on the fair value of the construction services provided in exchange for the right to charge third-party users for use of the service. The intangible asset is then amortized over the operations phase. The operating entity also recognizes revenue during the operation services for fees collected from the third-party users. This accounting is illustrated in IFRIC 12, Example 2, and is consistent with what is described in paragraph 36(a) above. Staff Analysis and Alternatives 39. If, based on the resolution of Issue 1, there are situations in which the operating entity has two customers in an SCA (that is, the grantor is the customer for the construction services and the third-party users are the customer for the operation services), the staff has identified the following two alternatives for resolution of Subissue 1A. Alternative A: Recognize revenue for the construction services provided in exchange for an intangible asset measured at fair value. Alternative B: Allocate the consideration in an SCA between construction and operation services and apply the revenue recognition criteria separately for each service. 40. Proponents of Alternative A observe that the grantor is economically providing a contractual right to the operator for the construction services (that is, a right to charge users of the infrastructure). They also note that recognizing an intangible asset for the construction services provided would align GAAP more closely with IFRIC 12 as previously described (the intangible asset model). Page 17 of 35

18 41. Proponents of Alternative B do not think it is appropriate to recognize more revenue than cash ultimately collected during the arrangement, as illustrated in paragraph 36(a) above, based on current GAAP. 42. Other constituents think that both alternatives would be acceptable considering there is no existing framework in GAAP to answer that question. Staff Recommendation 43. Considering that the staff is recommending Alternative A in Issue 1, Subissue 1A would not be applicable. However, if the Task Force tentatively concludes that there are situations in which the third-party users could be the customer of the operation services (Alternative B of Issue 1), the staff would recommend Alternative B of Subissue 1A. This is because Alternative B would be consistent with how an operating entity records revenue for construction services when it determines that the grantor is the customer of all phases of an SCA (that is, construction and operation services). The staff also believes that, while the form of the consideration paid by the operating entity to the grantor in exchange for the right to charge third-party users may be different (for example, a cash payment of $500 million in Scenario 1 compared to construction services provided with a fair value of $500 million in Scenario 2), the substance is the same and results in the operating entity obtaining the same right to charge third-party users. Question 3 for the Task Force 3. If the Task Force tentatively concludes in Issue 1 that there could be situations in which the third-party users are the customer of the operation services (Alternative B of Issue 1), does the Task Force agree with the staff s recommendation for recording revenue for construction services when all the consideration is tied to the operation services? Disclosures 44. If, based on the resolution of Issue 1, there are situations in which the third-party users could be the customer of the operation services, the staff evaluated whether additional Page 18 of 35

19 disclosures would be required with respect to revenue recognition (irrespective of whether Alternative A or Alternative B of Subissue 1A is selected). In doing so, the staff considered the existing disclosure requirements in GAAP. Paragraph states: Disclosure of accounting policies shall identify and describe the accounting principles followed by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations. In general, the disclosure shall encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods. The staff also considered the disclosure requirements in paragraphs and 50-2 related to multiple element arrangements, and the disclosure requirements in Section Because revenue recognition in Subissue 1A will generally involve some level of judgment, the staff believes that an entity should disclose its revenue recognition policy in accordance with paragraph In addition, because the transactions in Subissue 1A generally have multiple units of accounting (or performance obligation), such as the construction services and operation services described in this paper, the staff believes that an entity should disclose its revenue recognition policy for each unit of accounting (or performance obligation) and how the units of accounting (or performance obligations) are determined and valued. These accounting decisions often involve significant judgment, and there are existing GAAP disclosure requirements in place to do so (that is, no further standard setting would be required). For example, Topic 606 requires entities to disclose certain significant judgments made in the application of the revenue guidance. Staff Recommendation 46. The staff does not recommend adding any disclosure requirements, on the basis of the disclosure requirements currently in place. The staff also observes that an entity is required to disclose certain information as a result of adopting a change in accounting principle in accordance with Section Refer to the Transition Disclosures Page 19 of 35

20 section for further information on the required disclosures in accordance with Section Question 4 for the Task Force 4. If the Task Force tentatively concludes in Issue 1 that there could be situations in which the third-party users are the customer of the operation services (Alternative B of Issue 1), does the Task Force agree with the staff s recommendation that no additional disclosure requirements are needed with respect to Subissue 1A? Issue 2: Whether Major Maintenance in an SCA Is a Separate Deliverable 47. When an operating entity is required to periodically perform major maintenance, such as resurfacing a toll road as illustrated in the base example, a question may arise about whether such major maintenance is a separate deliverable when applying the revenue recognition guidance in Subtopic This issue is important because it could significantly impact the timing of the recognition of revenue for major maintenance activities and when the related costs are incurred. 48. While the agenda request was specifically related to the application of Topic 605, the staff notes there also is a model (Step 2 identify the performance obligations in the contract) under Topic 606. Additionally, in April 2016, the Board issued Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which is expected to reduce the cost and complexity of applying the guidance on identifying promised goods or services within the new revenue model. Industry Practice and Outreach 49. Some stakeholders assert that an operating entity should follow the guidance in Subtopic to determine whether major maintenance is a separate deliverable, irrespective of who the customer is. Based on the terms of the arrangement (including how major maintenance is defined in the SCA), it could be a separate deliverable. For other outreach Page 20 of 35

21 participants, it depends on who the customer of the operation services is and, to the extent the grantor is the customer, major maintenance is always a separate deliverable. Finally, other stakeholders note that (a) if the grantor is the customer, major maintenance could be a separate deliverable depending on how the arrangement defines it, and (b) if the thirdparty users are the customer, major maintenance is not a separate deliverable. Consistency in the application of existing GAAP (Subtopic or Step 2 of Topic 606) for similar transactions 50. Based on outreach performed, the staff observes that evaluating whether major maintenance is a separate deliverable tends to be more difficult when third-party users are the customer of the operation services, which results in diversity in practice. In contrast, while the evaluation still involves judgment and potentially could result in diversity in practice, stakeholders with whom the staff spoke generally observe the evaluation is easier when the grantor is considered the customer of the operation services. The staff received mixed feedback regarding whether additional accounting guidance would be needed to assist practitioners in determining whether major maintenance is a separate deliverable. Some stakeholders assert that existing GAAP is sufficient, and they can work through the facts and circumstances of a transaction to determine whether major maintenance is a separate deliverable (or performance obligation). Other stakeholders observe that additional guidance would be needed to the extent the Task Force tentatively concludes that the customer of the operation services could be the third-party users, because it would add complexity to the evaluation. Finally, other outreach participants noted that additional guidance would be needed irrespective of who the customer is, although they acknowledge it is less complex to perform the evaluation if the grantor is the customer. Additional guidance suggested could include illustrations, factors to consider in the evaluation, and/or how to apply the guidance in Topic 606 on implicit promises to major maintenance. Accounting Guidance under IFRIC The accounting for major maintenance under IFRIC 12 depends on which accounting model the operating entity applies: Page 21 of 35

22 (a) (b) If the financial asset model is applied, the operating entity evaluates whether major maintenance is a separate deliverable using the revenue guidance. IFRIC 12, Example 1, illustrates an example of a construct, operate, and maintain transaction with major maintenance required, under which the operating entity identifies three separate deliverables: construction services, operation services, and major maintenance. If the intangible asset model is applied, IFRIC 12 requires major maintenance to be recognized and measured in accordance with IAS 37, Provisions, Contingent Liabilities, and Contingent Assets. The operating entity measures major maintenance at its best estimate of the expenditure required to settle the present obligation at the end of the reporting period (that is, it accrues for the future major maintenance in each period taking into account the time value of money). Staff Analysis and Alternatives 52. The staff has identified four alternatives that may be considered for resolution of Issue 2. Alternative A: Major maintenance is always a separate deliverable. Alternative B: Major maintenance is never a separate deliverable. Alternative C: Depends on who the customer of the operation services is if the grantor is the customer, the major maintenance is a separate deliverable; if the customer is the third-party users, the major maintenance is not a separate deliverable. Alternative D: Apply the existing revenue model (no standard setting required). Alternative A: Major maintenance is always a separate deliverable 53. Proponents of Alternative A observe that the major maintenance improves the existing infrastructure, which is an asset of the grantor. Thus, the major maintenance is provided to the grantor and meets all the criteria in Subtopic to be accounted for as a separate deliverable. 54. Opponents of Alternative A note that this analysis should be based on the facts and circumstances of the arrangement, using the guidance in Subtopic , to determine Page 22 of 35

23 whether the major maintenance meets the criteria to be accounted for as a separate deliverable. Therefore, it could be a separate deliverable, depending on how it is defined in the arrangement. One opponent asserts that if the customer of the operation services is the third-party users, major maintenance cannot be a separate deliverable. Alternative B: Major maintenance is never a separate deliverable 55. Proponents of Alternative B observe that the operating entity is the beneficiary of the major maintenance. Without the major maintenance the infrastructure would deteriorate and the operating entity would not receive all the economic benefits under the SCA. Thus, these proponents assert that major maintenance is not a deliverable under the SCA. 56. Opponents of Alternative B observe that the analysis should be based on the facts and circumstances of the SCA using the guidance in Subtopic and, therefore, major maintenance may or may not be a separate deliverable depending on the terms of the arrangement. Some opponents of Alternative B also observe that major maintenance can be a separate deliverable in many cases. Alternative C: Depends on who the customer of the operation services is if the grantor is the customer, the major maintenance is a separate deliverable; if the customer is the third-party users, the major maintenance is not a separate deliverable. 57. Proponents of Alternative C assert that if the grantor is the customer of the operation services, then major maintenance is a separate deliverable because it enhances an infrastructure that the grantor owns. If the third-party users are the customer of the operation services, major maintenance is not a separate deliverable. The operating entity directly benefits from the major maintenance because it enhances its ability to charge the third-party users for its services. 58. Some opponents of Alternative C observe that the operating entity should use the guidance in Subtopic , irrespective of who the customer is, to determine whether the major maintenance is a separate deliverable. Other opponents note that even if the grantor is the customer of the operation services, the operating entity still needs to apply Subtopic to determine whether the major maintenance is a separate deliverable (that is, it is not an always situation). Page 23 of 35

24 Alternative D: Apply the existing revenue model (no standard setting required) 59. Proponents of Alternative D note there is an existing model in GAAP (Subtopic ) that addresses whether multiple deliverables in an arrangement involve more than one unit of account. Irrespective of who the customer is, proponents of Alternative D assert that the operating entity should determine, based on the terms of the arrangement, whether major maintenance is a separate deliverable using this existing guidance, and that additional guidance is not necessary. 60. Opponents views of Alternative D are consistent with the views expressed by proponents of Alternatives A, B, and C. Staff recommendation 61. Overall, the staff believes that there are appropriate models in place (that is, the multiple element arrangements guidance in Subtopic or Step 2 of Topic 606) that provide a framework to assist entities in arriving at consistent conclusions for consistent fact patterns. While the framework should assist in reducing diversity in practice to a reasonable level, it cannot eliminate all diversity, because the application of the existing models inevitably involves the use of judgment. However, if the Task Force tentatively concludes that the grantor is the customer of the operation services in all cases (Alternative A) for Issue 1, the staff thinks that it will eliminate the source of diversity (and additional complexity) created by the uncertainty around who the customer is. Therefore, the staff believes Issue 2 should be addressed by the Task Force only to the extent it tentatively concludes on Alternative B in Issue 1. That is, the Task Force should provide additional guidance to address the complexities involved in the evaluation when potentially having the third-party users as the customer of the operation services. The staff does not recommend providing additional guidance on Issue 2 at this time if Alternative A of Issue 1 is chosen. In this situation, the staff believes that an entity would apply the models currently in place, which should generally result in consistent outcomes for consistent fact patterns. 62. The staff also notes that an operating entity generally should disclose its accounting policy on major maintenance in accordance with paragraph , as previously Page 24 of 35